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National Income Accounting

INTRODUCTION Lecture-3
Select Theoretical Problems and Numerical Exercises

Theoretical Problems:
1. Explain in not more than seven lines why the following statements are true or false:
a) The difference between investment and saving in a country equals the excess of
government revenue over government expenditure plus country’s balance of trade with the
rest of the world.
b) The difference between the gross national product and the gross domestic product equals
the surplus in the balance of trade?
2. Show the linkages between households, firms and the government through a Circular flow
diagram.
3. Explain the identity between the sum of the value added of all productive units in a country
and its consumption plus investment plus government expenditure plus export minus
imports?
4. a) State and explain the basic macroeconomic identity for an open economy with government
sector. b) Show with the help of national income accounting: i) an increase in taxes must
imply a change in trade balance, government spending or saving investment balance. ii) an
increase in both consumption and savings must imply in increase in disposable income.
5. a) Explain the concept of value added. b) Distinguish between: i) Gross National product and
Gross Domestic Product; ii) National Income and Personal income.
6. Can NDP AND NI of a country be equal? Explain using the definitions of the two. (NDP = Net
Domestic Product and NI = National Income).
7. Using the two sector circular flow diagram show how GDP is both – total income of all earning
members in the economy and total expenditure on the economy’s output of all final goods
and services.
8. What adjustments do you suggest to calculate Personal Disposable Income from Gross
Domestic Product?
9. Show that in national income accounting saving is equal to the sum of investment,
government deficit and net exports. Why does this happen?
10. (a) Discuss the role of unplanned changes in inventory in maintaining the basic GNP identity.
(b) Explain why the following payments are added in deriving personal income from National
Income. (i) Transfer earnings; (ii) Interest payment by Government.
11. Use the national income identity condition to derive the relationship among the private
saving, public saving, investment and net exports in an open economy.
12. Explain the national income accounts identity C + I + G + X – M ≡ Y ≡ C+S +T
13. Define Personal Disposable Income. Indicate and explain the series of adjustment that takes
us from Gross Domestic Product to Personal Disposable Income.
14. Explain, in brief, the basic Macroeconomic structure of a closed economy. Suppose that you
are given the GNP of an economy for a particular accounting year. Explain how you can find
out the N.I.; disposable personal income; personal consumption expenditure from the GNP.
15. Define GNP of an open economy. Explain the circular flow of national product of a closed
economy by considering two sectors and four sectors separately. What are leakages in the
circular flow?
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16. Derive the basic GNP identity of an open economy and explain the same. Also explain the
process of derivation of personal income from national income of an economy.
17. Distinguish between national income at factor cost and the same at market prices. Consider a
closed economy and explain the circular flow of national product along with its leakages.
18. Distinguish between GDP and GNP of an economy. Explain the process of derivation of the
basic GNP identity of an open economy.
19. (a) What is the guarantee that the demand for output by components is identically equal to
the income generated by GDP. Explain your answer through the NI accounting. (b) Why are
Net Factor Incomes from abroad added to derive GNP from GDP and why are indirect taxes
deducted from GNP to derive NI.

Numerical Examples:

(i) Value Added Method:

It is also known as ‘production’ or ‘net output’ method. The main steps are:
Step 1: Estimate Gross Value Added at Market Price (GVAmp) by each firm/ industry.
GVAmp = Value of output -- Intermediate costs
= Sale of goods (Rs.) – Purchase of intermediate products (Rs.)
Example 1: Suppose Firm X sells materials worth Rs.1000 to Firm Z and Firm Y sells materials
worth Rs.800 to Firm Z. Firm Z sells intermediate products worth Rs.900 to Firm X and Rs.700 to
Firm Y. Also Firm Z sells goods worth Rs.1100 to Household, Rs.200 to Government and Rs.100 to
Rest of the world. Find GVAmp by each Firm.
Solution: Sale of Firm X = Rs.1000; Purchase of intermediate products by Firm X = Rs.900
GVAmp by Firm X = Rs.1000 – Rs.900 = Rs. 100
Sale of Firm Y = Rs.800 ; Purchase of intermediate products by Firm Y = Rs.700
GVAmp by Firm X = Rs.800 – Rs.700 = Rs. 100
Sale of Firm Z = Rs.900 + Rs.700 + Rs.1100 + Rs.200 + Rs.100 =3000 ;
Purchase of intermediate products by Firm X = Rs.1000 + Rs.800 = Rs.1800
GVAmp by Firm Z = Rs.3000 – Rs.1800 = Rs. 1200
Step 2: Take sum of GVAmp to arrive at GDPmp.
GDPmp = ∑ GVAmp
Example 2: Find GDPmp for the above example.
Solution:
GDPmp = ∑ GVAmp = GVAmp by Firm X + GVAmp by Firm Y+ GVAmp by Firm Z
= Rs.100 + Rs. 100 + Rs. 1200 = Rs.1400
Step 3: Deduct Depreciation (D) or Consumption of Fixed Capital (CFC) from
GDPmp to arrive at NDPmp.
NDPmp = GDPmp – D
Example 3: If Firm X has Rs.25 as depreciation, Firm Y has Rs.15 and Firm Z has Rs.50, find out
NDPmp for Example 1.
Solution: D = ∑ D = DX + DY + DZ = Rs.25 + Rs.15 + Rs.50 = Rs.100
NDPmp = GDPmp – D = Rs.1400 – Rs.100 = Rs. 1300
Step 4: Deduct indirect taxes from and add subsidies to NDPmp to arrive at NDPfc.
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NDPfc = NDPmp – Indirect Taxes + Subsidies
Example 4: In Example 1, if Firm X and Firm Y are given subsidies of Rs.20 and Rs. 10 respectively
while a sales tax of Rs. 60 is levied on Firm Z, find NDPfc.
Solution: NDPfc = Rs. 1300 – Rs.60 + Rs. 20 + Rs. 10
= Rs.1300 – Rs.30 = Rs.1270
Step 5: Add net factor income received from abroad (NFIA) to NDPfc to get NNPfc,
i.e. National Income.
NNpfc = National Income = NDPfc + NFIA
Example 5: In Example 1, if the country imports goods worth Rs.175, find out NI.
NFIA = X – M =Rs.100 -- Rs.175 = -- Rs.75.
NNpfc = National Income = Rs.1270 -- Rs.75 = Rs. 1195.
(ii) Income Method:
Step—1: Take the sum of the following factor incomes originating in all the industrial sectors of the
economy to arrive at NDPfc,
(a) Compensation of employees (COE)
(b) Rent and royalty (R)
(c) Interest (I)
(d) Profit (P)
(e) Mixed income of the self-employed (MI)
Example: Calculate NDPfc by income method from the following data:
Compensation of employees (COE) 310
Rent (R) 55
Interest (I) 75
Profits (P) 60
Mixed income of the self employed (MI) 365
Solution: NDPfc = COE + R + I + P + MI = 310 + 55 +75 + 60 + 365 = 865
Step 2: Add ‘Net Factor Income from Abroad’ (NFIA) to NDPfc to arrive at NNPfc = National Income
Example 6: In the above example if Net Income from Abroad is –45, find out NNPfc = National
Income
Solution: NNPfc = NDPfc + NFIA =865 + (--45) = 820

(iii) Final Expenditure Method:

Step 1: Take the sum of final expenditures i.e. expenditures on final products to arrive at GDPmp.
Final expenditures are broadly classified into the following four components:
(1) Private final consumption expenditure (PFCE) by
(a) Resident households
(b) Non-profit institution serving households
(2) Government’s final consumption expenditure (GFCE)
(3) Gross domestic capital formation (GDCF) comprising of
(a) Gross domestic fixed capital formation(GDFCF), which consists of
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i. Net domestic fixed capital formation (NDFCF)
ii. Consumption of fixed capital (CFC)
(b) Net addition to stocks( = closing stock -- opening stock)
(4) Net exports (NX) ( = Exports--Imports)
Thus, GDPmp = PFCE + GFCE + GDCF + NX
Example 7: Calculate GDPmp for a country from the following data:
Opening stock (OS) of
Primary sector 5
Secondary sector 5
Private final consumption expenditure (PFCE) 630
Net domestic fixed capital formation (NDFCF) 130
Government’s final consumption expenditure (GFCE) 85
Closing stock (CS) of
Primary sector 15
Secondary sector 10
Consumption of fixed capital (CFC) 50
Net exports (NX) 0
Solution: We know GDPmp = PFCE + GFCE + GDCF + NX
Here, PFCE = 630
GFCE = 85
GDCF = GDFCF + Net addition to stock
= (NDFCF + CFC ) + (CS –OS)
= (130 + 50) + ( 15 + 10 –5 —5)
= 180 +15
= 195
NX = 0
Thus, GDPmp = 630 + 85 + 195 + 0 = 910
Step 2: Subtract Consumption of Fixed Capital (CFC) from GDPmp to arrive at NDPmp.
NDPmp = GDPmp -- CFC
Step 3: Subtract indirect taxes and add subsidies to arrive at NDPfc.
NNPfc = NDPmp
(d) Add net factor income from abroad to get NNPfc. i.e. national income.

Numerical Exercises:

1. Assume that in a hypothetical economy GNP is Rs. 5000, personal disposable income
(aggregate) Rs. 4100 and the government budget deficit is Rs. 200 Consumption is Rs. 3800
and the trade deficit is Rs. 100. i) What is the size of investment (I)? ii) How large is
government spending (G)
2. You are given the following data in crores of rupees
Govt. and business transfer 15
Indirect business taxes 30
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GNP 630
Social security contributions 20
Personal taxes 25
Capital consumption 80
Residential construction 70
Retained earnings 0
Personal consumption expenditure 390
Direct business taxes 40
Calculate the value of NNP, national income personal income and disposable income.
3. The following is the information from the national income accounts of a hypothetical country:
GDP Rs. 6000
Gross Investment Rs. 800
Net Investment Rs. 200
Consumption Rs. 4000
Government purchase of goods and servicesRs. 1100
Government budget surplus Rs. 30
Calculate NDP, Net exports, Government taxes minus transfer, disposable personal income,
personal saving.
4. Consider the following data of a given year of an economy, which has only two firms: Firm 1
and Firm 2. Firm 1 and Firm 2 produced bread and flour worth Rs.400 and Rs.300 respectively.
Firm 2 sold Rs.250 worth of flour to Firm 1 which used (3/4) of it to produce bread. Firm 1
sold Rs.350 worth of bread to households. Firm 1 paid Rs.250, Rs.20 and Rs.10 and Firm 2
paid Rs.200, Rs.30 and Rs.25 respectively as wages and salaries, rent and interest. Using these
data explain why GDP equals (i) the sum of value added, (ii) aggregate final expenditure and
(iii) sum of factor incomes.
5. An economy has two firms. Households own all of the labour services and all of the capital,
which they rent out to firms. Firm A produces sugar using labour services worth Rs. 10 and
capital services worth Rs. 20. It sells Rs. 5 worth of sugar to households and Rs. 25 worth of
sugar to Firm B, a Bakery. The Bakery produces cakes worth Rs. 80 which it sells directly to
households. Households earn Rs. 30 in wages from Firm A and B combined.
(i) What is the value of GDP in this economy ?
(ii) What is the value added of Firm A?
6. Assume that GDP is Rs.6000, personal disposable income is Rs.5100, the government budget
deficit is Rs.200, consumption is Rs.3800 and the trade deficit is Rs.100. Find the values of
saving, investment and government spending.
7. For a particular country we have the following data:
GDP at market prices 15000
Exports 3000
Imports 5000
Net factor incomes from abroad 2500
Depreciation 3500
Gross Domestic Capital Formation 4500
What is the GNP at market price of this country?
8. Payasia is a closed economy in which only three commodities are produced : milk, rice and
payasam ( made out of milk and rice). In the year 2001, Rs. 1000 worth of rice, Rs. 600 worth
of milk and Rs. 800 worth of payasam were produced. Rs. 200 worth of rice and Rs. 300 worth
of milk were used up to produce the payasam that year. Assuming that Payasia had no stocks
of rice and milk at the beginning of the year 2001, what was the GNP in Payasia in 2001?
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9. The following are the complete set of items which are found in the national accounts statistics
of a country for the year 2000 – 01
i) Depreciation Allowances = Rs. 200
ii) Personal (direct) Tax payments = Rs. 250
iii) Indirect Business Taxes = Rs. 200
iv) Corporate (profits) Taxes = Rs. 100
v) Dividend payments = Rs. 50
vi) Undistributed profits = Rs. 50
vii) Government Transfer Payments = Rs. 200
viii) Personal Consumption Expenditure = Rs. 1200
ix) Personal Savings = Rs. 100
Use the above entries to compute a) Personal income; b) Net National Product; c) National
Income; d) Gross National Product; for this country for the year 2000-01.

Abbreviations generally used in NI Accounting:

Consumption of fixed capital/Depreciation CFC/Dep.
Indirect taxes IT
Subsidies Sub.
Net factor income received from abroad NFIA
Factor income received from abroad FIA
Factor Income paid to abroad FPA
Net factor income paid to abroad NFPA
Compensation of employees COE
Gross value added GVA
Net value added NVA
Market price mp
factor cost fc
Private final consumption expenditure PFCE
Households final consumption expenditure HFCE